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‘Grand bargain’ or ‘Grand larceny’?
'Grand Bargain' or 'Grand Larceny'? The "grand bargain'some utilities are proposing as well as most arguments for stranded cost compensation ring utterly false. It is changing technology, consumers' desire for choice in essential services, and potential state actions that have utilities running scared, and nothing thefeds have done has anything to do with this. The government should be most wary of claims for afederal bailout. Robert C. McDiarmid Bob McDiarmid is a partner in the Washington, D.C. law firm of Spiegel & McDiarmid, which represents state-, city-, and cooperatively owned utilities, state public service commissions, people's counsels, and other bodies in energy and environmental matters. He was an active participant in the congressional passage of EPAct, during which he and his firm represented the Transmission Access Policy Study Group (TAPS). Mr. McDiarmid earned his Master's degree from Cornell University in engineering physics and his law degree from Harvard. The views expressed here are his own, and do not necessarily represent those of clients ofhis firm or of other attorneys in the firm.
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What experience and history teach is this--that peoples and government never have learned anything from histor~ or acted on principles deducible from it. ---G.W.F.Hegel Those who cannot remember the past are condemned to fulfill it. ---George Santayana Obert W. Service once obrved that "There are strange things done in the midnight sun, by the men who moil for gold." This was an accurate observation about h u m a n nature, as well as about the far North. Service's assumption about the "queerest [of these strange
things]," however, may well have been surpassed by those who now assert the desirability of a "grand bargain" in electric restructuring. That grand bargain-which would sell all a utility's transmission facilities to a new entity at a substantial markup and use the profits to pay for some or all of the utility's so-called "stranded c o s t s ' m w o u l d cuff the hair of the regulators who spent a good part of their lives, following the enactment of the Federal Water Power Act in 1920 and the Federal Power Act in 1935, in "wringing the water" out of the accounts of utilities. That "water," or "added value," had been inserted, by Samuel Insull and oth-
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ers of his ilk, through a series of "financial engineering" deals in which assets had been traded back and forth in daisy chains on the theory that the consumers and the economy could stand paying for the extra amount involved in the write up to "replacement value" because the assets involved were of higher real value than their then book value. That "financial engineering" led, in not insubstantial part, to the financial collapse of the holding companies in the recession and then the depression, and with them the collapse of many other industrial enterprises. This article suggests that the "grand bargain" now being proposed has no more substance or validity than the "financial engineering" involved in the holding company debacle of the 1920s and 1930s. he "grand bargain" now proposed from several quarters would have utilities sell (or rent) electric transmission facilities to some independent or quasiindependent entity at a price reflecting a massive "write-up" of the facilities' cost. Some of these proposals are premised on a writeup to someone's idea of replacement cost. Others are premised on a doubling of the net book cost of the facilities. Yet others are based on a multiplier applied to the original cost of the facilities. In principle, a portion of the value gained by the write-up would be applied to a "write-down" of uneconomic generating assets or of "regulatory assets." In many of the "grand bargain" proposals, some portion of the added value
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of the write-up of transmission would go to the shareholders. The impression that most of the proponents of the "grand bargain" leave is that many or most problems of the industry will thereby be solved: • There will be a common grid transmission system entirely separated (in control and possibly in ownership) from the owners of the generation resources and of distribution facilities, so that the generation market will work with-
The Grand Bargain argument assumes that costs are stranded solely because of something that the federal government has done.
out impediment, making the economists happy. • The generation facilities which are now too expensive to compete with market prices will be written down to a competitive level, taking care of all stranded investment problems, so that utilities can be viable competitors in the generation market, making utility management happy: • Utility shareholders and bondholders will have been given enough lagniappe so that they will be happy not to object to the disaggregation of transmission.
• Costs of power at wholesale (and retail, if restructuring on the earlier California model goes through) will drop precipitously so that ratepayers are happy (ignoring the burden on them from excessive transmission prices). • God will be in his (or her) heaven and all will be right with the world. Of course, higher transmission costs will reduce the number of transactions in generation which could be made, and that will, in turn, reduce the savings to consumers from having generation operate most efficiently, but that also seems to be ignored) The Grand Bargain argument is a variation on the stranded cost argument, and builds upon it. Both assume that there are high costs which are stranded, not because of improvidence in design of, contracting for, or construction of generating resources, but solely because of something that the federal government has done since 1992, and that the federal government therefore has a responsibility to pay itself or force others to pay for those high costs. While there are certain logical and legal infirmities that should be obvious once the proposition is stated, the purpose of this paper is to address some of the public policy implications that may not be as obvious. While it is not entirely unexpected that utility executives would wish to create additional value for their shareholders from any asset available, what is now surprising is that the idea was not rejected out of hand by the entire 43
regulatory community. Perhaps proving the points of Santayana and of Hegel, above, the daimed benefit from the concept---of getting something for nothing and solving the problems of the industry without pain--are bringing the "grand bargain" what appears to be significant if not yet serious consideration. he argument behind the "grand bargain" proposition is based on the assumption that transmission is undervalued when priced on a cost-of-service basis. Why does that argument seem to pass the "laugh" test with some regulators and economists? Perhaps because it has constantly been repeated for nearly a decade by those who wish to charge more for transmission, so that it has now become a mantra. New transmission facilities are frequently more expensive than old ones of similar size and voltage, but there are also improvements in technolog3a2 Moreover, economies of scale are still available, and there are social impediments to construction of duplicating transmission lines, so that natural monopoly characteristics are still apparent in the transmission segment of the industry There is another natural monopoly characteristic of transmission that adds to the perceived value rights of way. Rights of way have been acquired, directly or indirectly, through eminent domain. Eminent domain proceedings, when they are needed, are brought in the name of, and for the good of, the people of the state involved, rather than in the
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name of the utility directly. It would be hard to think of an easier case for a lawyer to oppose than an eminent domain proceeding brought for the purpose of acquiring land for a transmission line to be sold at a high markup for the benefit of shareholders. Such facilities are dearly imbued with a public purpose and were understood to be used for that purpose. If there is an enhance-
The "grand bargain" proposition is based on the assumption that transmission is undervalued when priced on a cost-of-service basis. Why does that pass the "laugh" test ?
ment of value because of scarcity values imposed by society, there is no inherent reason why that enhancement should be recoverable by the utility rather than by the public---or perhaps by the landowner whose land was condemned for the public purpose the utility now proposes to abandon. There is a very basic reason why natural monopolies are ordinarily regulated with price developed from the cost of service based on the original price paid. The price of the essential facility is built into the cost to all users--
businesses which compete on the world market and which incorporate the price of the services into the price of the product, and ordinary citizens whose disposable income is depleted each month by the price charged for the services. It is important to society that the value extracted for the use of these monopoly services from all citizens be no more than would be the case if the price were set by perfect competition rather than regulation - - i.e., the cost of service of an efficient competitor. here are good reasons why "fair value"--usually replacement value regulation was generally abandoned long ago. One reason is that replacement value has the potential to go up and down so that investors in utility property risk appreciably more. Another is that if the risk of investors who get the benefit of appreciation with the market is much less tied to the basic business of the utility, so that the return allowed on utility business is considerably less, the investors become speculators, with an entirely different set of risk/benefit expectations. Since competitors are forced to use the natural monopoly transmission facilities owned by others to meet the needs of society and efficienc34 competitors have relied upon the pricing of transmission facilities on a cost-of-service basis in siting their own generation facilities in locations which are good for society and for the area electrical grid as a whole. In New England, for example, there are very few utilities that do not de-
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pend in substantial part on generation that is located on transmission facilities owned by others. Many of those generation facilities are so-called "pool-planned" facilities, which were sited for the good of the region as a whole. That is also true but ordinarily to a lesser extent--in any region where the siting authorities take into account the costs to society as a whole in siting generation. The basic point here is that many utilities and consumers depend on generation that requires use of transmission facilities owned by others. Any shift from cost-ofservice based regulation to some other form at higher prices has the effect of subsidizing the transmission owner at the expense of those who have relied--frequently at the behest of governm e n t - - u p o n the continuation of cost-based regulation of transmission in acquiring generation assets to meet their own load efficientl~ n fact, many entities that have relied upon cost-based regulation of transmission rates---including most publicly owned utilit i e s - h a v e generation and social costs which are just as "stranded" as those of the transmission owners. Many of these entities bought into high-cost generation units which are n o w being touted as a reason for the "grand bargain" in order to obtain the transmission service which the predecessors of the current FERC did not find it expedient to order. High generation costs are scarcely the sole responsibility of IOUs with transmission.
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Virtually all assertions by the parties to this debate deserve careful examination, if only because the consequences are so significant. It is thus important to examine the underlying premises of each argument with care. In doing so, one will notice that for some parties the premises underlying certain contentions are diametrically opposed to premises of other contentions of the same party; there is little or no consis-
Many that have relied upon cost-based regulation of transmission have costs which are just as "stranded" as those of transmission owners.
tency of position. In this context, perhaps a statement of the premises assumed in this paper would be useful. Premise No. 1: Generation Is No Longer an Inherent Part of Any "Franchise or Quasi-Fran-
son for completion, in many cases, was that utilities believed that regulators would be so trapped by the process that they would permit the full costs to be passed on to the ratepayers, and that elasticity of demand would not cause problems. These examples made it dear that there were no longer natural monopoly characteristics inherent in the generation portion of the industry. 4 Congress recognized this phenomenon in 1978 in the Public Utility Regulatory Policies Act, and the "must-buy" provisions applicable to qualifying facilities severed any remaining assumption that utilities should always build and own their own generation. The process required by PURPA, by which state public utility commissions determined "avoided costs" for such QF power, resulted in the PUCs looking, many for the first time, at the problems of acquiring power supplies. Many soon recognized that utilities had not always done the best job of creating a low-cost supply of power for their customers. Thus the commissions also concluded that acquiring non-utility power supplies through competitive bidding was frequently a better and cheaper way of developing power supplies.
chise'Right of Any Utility s Utilities themselves, in many cases, constructed generation resources that were far too expensive and inefficient, which clearly would have been canceled at an early stage if the market for electricity had been subject to competitive discipline. The only rea-
Premise No. 2. The 1992 Passage
of EPAct Did Not Itself Change the Relationship of Segments of the Industry in Any Way Adverse to the Interest of Utilities EPAct did two relevant things of substance, however.
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First, and perhaps m o r e important here, it permitted regulated utilities to create EWGs subsidiary generating entities which would be essentially unregulated. This was a result sought by investor-owned utilities who argued that the generation market was already (or would soon be) disciplined by competition rather than regulation, and no longer was subject to natural monopoly characteristics. Investor-owned utilities wished to participate in that market, in which efficiency would govern whether profits were made or lost. Second, and very important for the long run, it gave FERC additional authority to require transmission and to do so on a broader scale than FERC had previously been willing to do.
processes under the Nuclear Regulatory Commission, the Securities and Exchange Commission, or the antitrust courts with relatively efficient processes under the Federal Power Act, as amended.6 FERC has conscientiously obeyed the congressional injunction to stay away from the question of whether retail wheeling should be required. Since passage of EPAct, many utilities have formed exempt wholesale generators (EWGs). Those EWGs, in turn, are doing what the independent power pro-
Premise No. 3: The Actions of
FERC Under EPAct Have Not Changed the Relationship of Segments of the Industry Few, if any, IOUs lacked some form of transmission well prior to the passage of EPAct. Few consumer-owned utilities (municipals or cooperatives) did not have some form of transmission available to them well prior to 1992.s What FERC has done under EPAct is to work toward removal of high transaction costs involved in acquiring or modifying transmission rights in order to permit the generation markets to come closer to working in a way that would impose significant competitive discipline. That change, however, has done nothing more than replace relatively inefficient
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years, simply because there are more players.8 The competitive pressures on utilities caused by at least partially competitive wholesale markets--and considerably exacerbated by the EWGs themselves--has led to embarrassing moments for utilities before PUCs, in which they have to try to explain the high cost of their own generation resources in comparison to those of others. None of these pressures, however, nor any of the other developments mentioned so far, has in any way changed the basic franchise or quasi-franchise relationship between the utility and the retail customers. Nor has it changed any of the basically contractual fights and relationships between the utility and other utilities at wholesale. All of these pressures are caused by technological change, not by legislative or regulatory change. hat costs are claimed may tell us something about the cause of the "cost stranding" which is asserted. EEI asserts in its comments to the Federal Energy Regulatory Commission in FERC's stranded cost docket9 that there are over $75 billion in stranded costs, but the only such costs which EEI identifies in more than general way are "regulatory assets." All such "regulatory assets" are by definition costs which could not have been recovered in a competitive market but which have been capitalized for recovery to be permitted later by the PUC from the franchise or quasi-franchise customers, or which the recovery of
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ducer industry had previously been doing. They have constructed a number of generating units that are cheaper than many of those in the portfolios of the parent utilities, and have located them in areas where the utility portfolios are even more expensive.7This puts pressure on the utilities' own generation, as to which many have not been vigilant about controlling costs. All of this has expanded the secondary wholesale market in generation, in which "right to output" contracts are traded for periods ranging from a few hours to many
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the PUC for its own reasons determined to postpone. 1° EEI also asserts, with considerably less specifici~, that all generating reserves costs above marginal production costs have the potential to be stranded. While this point is never terribly clear, it appears to mean that they perhaps cannot be recovered from franchise or quasi-franchise customers. No such costs are claimed against other IOU customers who have bought for a period of years, whether or not they have used the transmission systems of those claiming the stranding, although EEI and others assert, rather halfheartedl~ that they should be able to collect such costs against nonIOU customers who have bought for a period of years, especially if they use the IOU transmission systems. All of the EEI comments, however, are really focused on state actions that would change their franchise or quasi-franchise customer base. n 'n other words, there is nothing .that has happened associated with any of the congressional or FERC actions that has "stranded" any costs so far. Unless the states abrogate the franchise or quasifranchise rights now in existence, the only "stranding" that has occurred is as a result of technological change or the construction by utilities of generation that is so expensive that it cannot be sold. ~2 The "restructuring" of the electric industry under consideration in many states (and which has generated a great deal of thought and paper in the California CPUC proceeding), which purportedly July 1995
drives the concept of the "grand bargain," has nothing to do with the FERC. It was initiated neither by Congressmindeed Congress prohibited FERC from requiring the direct customer access the states are considering--nor by any branch of the federal government. It is strictly a construct of the states responding to market pressures. In essence, California (which proposes permanent changes) and Michigan (which proposes changes as a limited experiment) expect to free almost all (for California) or a few (for
Michigan) retail customers to purchase generation resources on the bulk power market, rather than only from the vertically integrated utility to which they are attached. The utilities' stated concern is that those retail customers would purchase from suppliers which have no social costs imposed by the states, and without the large uneconomic generation costs with which many existing utilities (including the publicly owned utilities) in California and elsewhere are burdened. The basic premise that underlies both the Grand Bargain and many of the stranded cost arguments---
that costs have been stranded by federal actions---is basically false. While it is designed to pander to federal regulators' vanity, by convincing them that they have changed the world drastically rather than by making the process much more efficient, it is clear that the potential for any change that puts recovery of the claimed stranded costs at risk lies solely within the powers of the states. et us call a spade a spade. Utility costs that are "stranded" are stranded because the franchise and quasi-franchise customers that once were designated to bear those costs no longer will do so. That is either because the utilities' costs have gotten so high that the customer base left to pay the costs will be too small because of elasticity of demand, due to the state in question has abrogated the correlative rights and obligations of the utility and its retail customers. Nothing that has occurred at the federal level has caused that result. FERC has long held that there are no inherent obligations to serve at the federal level, so that wholesale relations are governed by contract. If the states wish to abandon the concept of a franchised retail provider, it is state action that causes the disconnection of that set of correlative rights and obligations. And if the utility has preserved its rights at retail with a franchise or equivalent, there is very little question that the state action constitutes a compensable taking for constitutional purposes. If the state "strands" costs, 13there is very lit-
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tie virtue or rationale in asking the federal government to pay for those costs or to have the federal government require competitors to pay for the costs that are claimed to be "stranded," especially w h e n those competitors have "stranded" costs of their own.
Neither FERC nor any other part of the federal government is responsiblefor the "stranding" of any of the costs asserted. Nor are the competitors. Indeed, as noted above, some of the competitors are simply the utilities themselves in other corporate guises. he idea behind the Grand Bargain, which is being p u s h e d by EEI and others in the stranded cost docket at FERC, seems to be that the federal government should require all consumers to pay higher rates for transmission services governed by FERC to p a y for costs caused by feared actions by the states that have not yet occurred. In an era in which " u n f u n d e d mandates" and "takings" are concepts which have attained significant emotional and political resonance in connection with federal imposition of costs on states, localities and citizens, it seems strange that the "grand bargain," which w o u l d have the federal governm e n t impose costs u p o n the citiz e n s ~ n o t because of anything the federal g o v e r n m e n t has done, and not even for any federal purpose, but to compensate utilities for damage which the states may do to them, or which technological advances have done to t h e m ~ doesn't pass the laugh test. It
seems as well to be running against a considerable political and economic tide. In the ordinary context, a utility that sought to charge twice as m u c h as its cost of service w o u l d warrant for its transmission service in order to drive its competition out of business w o u l d be thought to be stealing. That is because it w o u l d take the profits from one service where it had a m o n o p o l ~ and use t h e m to support--subsidize its generation service, which competes in a quasi-competitive market. That is precisely w h y tie-ins are per se il-
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TDUs have all of the overpriced generation--sometimes exactly the same overpriced generationm that the surrounding transmitting utilities have. Indeed, sometimes TDUs were induced to b u y into those units in order to obtain transmission rights to begin with. If transmission-owning competitors get to write d o w n their overpriced generation with m o n o p o l y profits, w h a t do TDUs get to write d o w n their overpriced generation with? Or are TDUs just p u t out of business, as m a n y of their competitors w o u l d prefer? Stealing is still stealing. The Grand Bargain w o u l d be grand larcen3a • Endnotes:
1. Perhaps more significantly, the numbers do not appear to work out and gold is not created from dross. That, however, is the subject of a more detailed analysis than is possible in the space available here.
legal under the antitrust laws. FPC v. Conway Corporation14m a d e it clear that this sort of thing is illegal in a regulated context as well. W h y is it different if the utility charges twice as m u c h as its cost of service in a one-time sale? It still takes the profits from a monopoly resource and uses them to subsidize its participation in a competitive market. Transmissiond e p e n d e n t utility competitors--those w h o are needed to make the competitive market that Congress prescribed function effectivelym have all of the social costs which are imposed on their competitors that o w n transmission lines.
2. The further system efficiencies tO be obtained from FACTStechnology are still being tested, but seem likely to be quite significant. 3. Reference to a "franchise or quasifranchise" right means that part of the "regulatory bargain" that includes an obligation on the part of a utility to provide power supply to a particular group of customers. While the particular customers in any such group may be a matter of dispute, it is clear that at least for those utilities with exclusive franchises in particular territories (or equivalent grants from the state) and the customers in those territories, there are correlative rights and obligations to serve and to take service. 4. The economies of scale which had been assumed to be available from ever-larger units turned out to be more than overcome by additional costs of operation and higher outage
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rates, and independent power producers began to develop generation and sell at much lower cost. 5. The author is one of the authors of the TAPS comments in the FERC stranded cost NOPR, FERC Docket No. RM94-7-000. Those comments include appendices of long-standing transmission arrangements in 31 states for which the information was readily available to TAPS, and also lists of municipal joint action agencies and generation and transmission cooperatives. Those lists show that by 1984, there were more than 53 joint action agencies in more than 30 states, and 52 G&T co-ops, many serving in more than one state. All of those enti6es had, or were in the process of obtaining through litigation or otherwise, some form of transmission access. 6. In the long run, the creation of an efficient market for generation services will, if not skewed by transmission owners, permit the sort of additional efficiencies that can develop from an actively competitive industrial segment rather than one constrained by artificial regulatory strictures. That would be a very significant accomplishment, and one that would add very considerably to the nation's welfare (not least in terms of industrial competitiveness in the world market). 7. This--and other evidence--suggests that the industry may again be in a declining cost phase. Whether this is true, and whether the reason for the declining cost phase (if it exists) is technological improvement, the perhaps temporary advantage of lowercost gas supply, or the impetus of the competitive market on design and construction techniques, are questions that are beyond the scope of this paper. It does, however, appear to be beyond dispute that the lower cost of the new generation is real and does not derive simply from the social or stranded cost burdens of utilities in the same market. 8. There have been active secondary wholesale markets of this sort for many years in places like New Eng-
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land and MAPP. Indeed, the whole concept behind the Western Systems Power Pool was to provide such a market in the West. However, it is this author's observation that the WSPP has not worked particularly well thus far because of the high transaction costs (and use costs) associated with transmission rights in that area. 9. Edison Electric Institute, Comments to Federal Energy Regulatory Commission, Docket No. RM94-7-000, at 18-27 (Dec. 9, 1994). 10. More than half of those regulatory assets that EEI asserts will be stranded are SFAS No. 109 costs, "income tax costs that would be expensed under GAAP, but are deferred for recovery through rates in the future when the tax costs are actually paid." The other
large category asserted by EEI--nearly a quarter of those regulatory assets---are "[p]hase-in, synchronization and other regulatory assets," which are said to "represent the costs of newly completed plants. Regulators require deferral to limit the impact on rates of the cost of new plants or to defer costs of new plants that would otherwise be unrecovered because of delays between the completion of the plant and changes in rates to reflect the recovery of such costs." Id. at 24, 27. 11. EEI also asserts concerns about "municipalization," carefully avoiding the fact that recent examples of municipalization all have been premised on obtaining whatever transmission service was needed prior to the passage of EPAct. The Town of Massena, New York, for example, obtained transmission well before to 1992. And
the City of Las Cruces, New Mexico, premised its late-1980s municipalization study, which is the basis for its present municipalization effort on being able to force transmission services from El Paso. Clyde, Ohio, which EEI cites as a horrible example (Id. at 59), established its municipal system in 1989, a fact that EEI takes care not to mention. While the passage of EPAct should have reduced the cost for litigation involved in forcing such transmission, EEI and others are seeking to impose an even higher barrier to municipalization than the pre-EPAct litigation cost through its bootstrap "stranded cost" argument. 12. The comment has been made that nuclear power has gone from being perceived as "too cheap to meter" to being perceived as "too expensive to matter." That newer perception is probably correct as to some of the more expensive nuclear facilities. 13. In addition to the regulatory asset claims made by EEI, note 10, supra, there have been assertions that high priced demand-side management and QF contracts are also "stranded." But those are unquestionably costs imposed by the state PUCs; FERC has had nothing to do with them. It may be that many IOUs chose not to contest arguments in favor of setting unrealistically high "avoided costs" because it made the option of completing an expensive generation project look good. But they certainly had the option to contest this and can hardly blame the FERC for their failure to do so. The case of Consumers Power Co. is instructive here. That large utility allegedly agreed to what many outsiders believed to be an excessive "avoided cost" rate to be fixed by the PUC, then contracted to buy 1240 MW of power from its own alleged QF affiliate, Midland Cogeneration Venture, L.P., and to apply that excessive "avoided cost" rate for at least 17 years. Opponents claimed that the windfall to MCV--and ultimately to Consumers Power's corporate parent--would be more than $1 billion. 14. 426 U.S. 271 (1976).
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What experience and history teach is this--that peoples and government never have learned anything from histor~ or acted on principles deducible from it. ---G.W.F.Hegel Those who cannot remember the past are condemned to fulfill it. ---George Santayana Obert W. Service once obrved that "There are strange things done in the midnight sun, by the men who moil for gold." This was an accurate observation about h u m a n nature, as well as about the far North. Service's assumption about the "queerest [of these strange
things]," however, may well have been surpassed by those who now assert the desirability of a "grand bargain" in electric restructuring. That grand bargain-which would sell all a utility's transmission facilities to a new entity at a substantial markup and use the profits to pay for some or all of the utility's so-called "stranded c o s t s ' m w o u l d cuff the hair of the regulators who spent a good part of their lives, following the enactment of the Federal Water Power Act in 1920 and the Federal Power Act in 1935, in "wringing the water" out of the accounts of utilities. That "water," or "added value," had been inserted, by Samuel Insull and oth-
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ers of his ilk, through a series of "financial engineering" deals in which assets had been traded back and forth in daisy chains on the theory that the consumers and the economy could stand paying for the extra amount involved in the write up to "replacement value" because the assets involved were of higher real value than their then book value. That "financial engineering" led, in not insubstantial part, to the financial collapse of the holding companies in the recession and then the depression, and with them the collapse of many other industrial enterprises. This article suggests that the "grand bargain" now being proposed has no more substance or validity than the "financial engineering" involved in the holding company debacle of the 1920s and 1930s. he "grand bargain" now proposed from several quarters would have utilities sell (or rent) electric transmission facilities to some independent or quasiindependent entity at a price reflecting a massive "write-up" of the facilities' cost. Some of these proposals are premised on a writeup to someone's idea of replacement cost. Others are premised on a doubling of the net book cost of the facilities. Yet others are based on a multiplier applied to the original cost of the facilities. In principle, a portion of the value gained by the write-up would be applied to a "write-down" of uneconomic generating assets or of "regulatory assets." In many of the "grand bargain" proposals, some portion of the added value
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of the write-up of transmission would go to the shareholders. The impression that most of the proponents of the "grand bargain" leave is that many or most problems of the industry will thereby be solved: • There will be a common grid transmission system entirely separated (in control and possibly in ownership) from the owners of the generation resources and of distribution facilities, so that the generation market will work with-
The Grand Bargain argument assumes that costs are stranded solely because of something that the federal government has done.
out impediment, making the economists happy. • The generation facilities which are now too expensive to compete with market prices will be written down to a competitive level, taking care of all stranded investment problems, so that utilities can be viable competitors in the generation market, making utility management happy: • Utility shareholders and bondholders will have been given enough lagniappe so that they will be happy not to object to the disaggregation of transmission.
• Costs of power at wholesale (and retail, if restructuring on the earlier California model goes through) will drop precipitously so that ratepayers are happy (ignoring the burden on them from excessive transmission prices). • God will be in his (or her) heaven and all will be right with the world. Of course, higher transmission costs will reduce the number of transactions in generation which could be made, and that will, in turn, reduce the savings to consumers from having generation operate most efficiently, but that also seems to be ignored) The Grand Bargain argument is a variation on the stranded cost argument, and builds upon it. Both assume that there are high costs which are stranded, not because of improvidence in design of, contracting for, or construction of generating resources, but solely because of something that the federal government has done since 1992, and that the federal government therefore has a responsibility to pay itself or force others to pay for those high costs. While there are certain logical and legal infirmities that should be obvious once the proposition is stated, the purpose of this paper is to address some of the public policy implications that may not be as obvious. While it is not entirely unexpected that utility executives would wish to create additional value for their shareholders from any asset available, what is now surprising is that the idea was not rejected out of hand by the entire 43
regulatory community. Perhaps proving the points of Santayana and of Hegel, above, the daimed benefit from the concept---of getting something for nothing and solving the problems of the industry without pain--are bringing the "grand bargain" what appears to be significant if not yet serious consideration. he argument behind the "grand bargain" proposition is based on the assumption that transmission is undervalued when priced on a cost-of-service basis. Why does that argument seem to pass the "laugh" test with some regulators and economists? Perhaps because it has constantly been repeated for nearly a decade by those who wish to charge more for transmission, so that it has now become a mantra. New transmission facilities are frequently more expensive than old ones of similar size and voltage, but there are also improvements in technolog3a2 Moreover, economies of scale are still available, and there are social impediments to construction of duplicating transmission lines, so that natural monopoly characteristics are still apparent in the transmission segment of the industry There is another natural monopoly characteristic of transmission that adds to the perceived value rights of way. Rights of way have been acquired, directly or indirectly, through eminent domain. Eminent domain proceedings, when they are needed, are brought in the name of, and for the good of, the people of the state involved, rather than in the
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name of the utility directly. It would be hard to think of an easier case for a lawyer to oppose than an eminent domain proceeding brought for the purpose of acquiring land for a transmission line to be sold at a high markup for the benefit of shareholders. Such facilities are dearly imbued with a public purpose and were understood to be used for that purpose. If there is an enhance-
The "grand bargain" proposition is based on the assumption that transmission is undervalued when priced on a cost-of-service basis. Why does that pass the "laugh" test ?
ment of value because of scarcity values imposed by society, there is no inherent reason why that enhancement should be recoverable by the utility rather than by the public---or perhaps by the landowner whose land was condemned for the public purpose the utility now proposes to abandon. There is a very basic reason why natural monopolies are ordinarily regulated with price developed from the cost of service based on the original price paid. The price of the essential facility is built into the cost to all users--
businesses which compete on the world market and which incorporate the price of the services into the price of the product, and ordinary citizens whose disposable income is depleted each month by the price charged for the services. It is important to society that the value extracted for the use of these monopoly services from all citizens be no more than would be the case if the price were set by perfect competition rather than regulation - - i.e., the cost of service of an efficient competitor. here are good reasons why "fair value"--usually replacement value regulation was generally abandoned long ago. One reason is that replacement value has the potential to go up and down so that investors in utility property risk appreciably more. Another is that if the risk of investors who get the benefit of appreciation with the market is much less tied to the basic business of the utility, so that the return allowed on utility business is considerably less, the investors become speculators, with an entirely different set of risk/benefit expectations. Since competitors are forced to use the natural monopoly transmission facilities owned by others to meet the needs of society and efficienc34 competitors have relied upon the pricing of transmission facilities on a cost-of-service basis in siting their own generation facilities in locations which are good for society and for the area electrical grid as a whole. In New England, for example, there are very few utilities that do not de-
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pend in substantial part on generation that is located on transmission facilities owned by others. Many of those generation facilities are so-called "pool-planned" facilities, which were sited for the good of the region as a whole. That is also true but ordinarily to a lesser extent--in any region where the siting authorities take into account the costs to society as a whole in siting generation. The basic point here is that many utilities and consumers depend on generation that requires use of transmission facilities owned by others. Any shift from cost-ofservice based regulation to some other form at higher prices has the effect of subsidizing the transmission owner at the expense of those who have relied--frequently at the behest of governm e n t - - u p o n the continuation of cost-based regulation of transmission in acquiring generation assets to meet their own load efficientl~ n fact, many entities that have relied upon cost-based regulation of transmission rates---including most publicly owned utilit i e s - h a v e generation and social costs which are just as "stranded" as those of the transmission owners. Many of these entities bought into high-cost generation units which are n o w being touted as a reason for the "grand bargain" in order to obtain the transmission service which the predecessors of the current FERC did not find it expedient to order. High generation costs are scarcely the sole responsibility of IOUs with transmission.
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Virtually all assertions by the parties to this debate deserve careful examination, if only because the consequences are so significant. It is thus important to examine the underlying premises of each argument with care. In doing so, one will notice that for some parties the premises underlying certain contentions are diametrically opposed to premises of other contentions of the same party; there is little or no consis-
Many that have relied upon cost-based regulation of transmission have costs which are just as "stranded" as those of transmission owners.
tency of position. In this context, perhaps a statement of the premises assumed in this paper would be useful. Premise No. 1: Generation Is No Longer an Inherent Part of Any "Franchise or Quasi-Fran-
son for completion, in many cases, was that utilities believed that regulators would be so trapped by the process that they would permit the full costs to be passed on to the ratepayers, and that elasticity of demand would not cause problems. These examples made it dear that there were no longer natural monopoly characteristics inherent in the generation portion of the industry. 4 Congress recognized this phenomenon in 1978 in the Public Utility Regulatory Policies Act, and the "must-buy" provisions applicable to qualifying facilities severed any remaining assumption that utilities should always build and own their own generation. The process required by PURPA, by which state public utility commissions determined "avoided costs" for such QF power, resulted in the PUCs looking, many for the first time, at the problems of acquiring power supplies. Many soon recognized that utilities had not always done the best job of creating a low-cost supply of power for their customers. Thus the commissions also concluded that acquiring non-utility power supplies through competitive bidding was frequently a better and cheaper way of developing power supplies.
chise'Right of Any Utility s Utilities themselves, in many cases, constructed generation resources that were far too expensive and inefficient, which clearly would have been canceled at an early stage if the market for electricity had been subject to competitive discipline. The only rea-
Premise No. 2. The 1992 Passage
of EPAct Did Not Itself Change the Relationship of Segments of the Industry in Any Way Adverse to the Interest of Utilities EPAct did two relevant things of substance, however.
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First, and perhaps m o r e important here, it permitted regulated utilities to create EWGs subsidiary generating entities which would be essentially unregulated. This was a result sought by investor-owned utilities who argued that the generation market was already (or would soon be) disciplined by competition rather than regulation, and no longer was subject to natural monopoly characteristics. Investor-owned utilities wished to participate in that market, in which efficiency would govern whether profits were made or lost. Second, and very important for the long run, it gave FERC additional authority to require transmission and to do so on a broader scale than FERC had previously been willing to do.
processes under the Nuclear Regulatory Commission, the Securities and Exchange Commission, or the antitrust courts with relatively efficient processes under the Federal Power Act, as amended.6 FERC has conscientiously obeyed the congressional injunction to stay away from the question of whether retail wheeling should be required. Since passage of EPAct, many utilities have formed exempt wholesale generators (EWGs). Those EWGs, in turn, are doing what the independent power pro-
Premise No. 3: The Actions of
FERC Under EPAct Have Not Changed the Relationship of Segments of the Industry Few, if any, IOUs lacked some form of transmission well prior to the passage of EPAct. Few consumer-owned utilities (municipals or cooperatives) did not have some form of transmission available to them well prior to 1992.s What FERC has done under EPAct is to work toward removal of high transaction costs involved in acquiring or modifying transmission rights in order to permit the generation markets to come closer to working in a way that would impose significant competitive discipline. That change, however, has done nothing more than replace relatively inefficient
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years, simply because there are more players.8 The competitive pressures on utilities caused by at least partially competitive wholesale markets--and considerably exacerbated by the EWGs themselves--has led to embarrassing moments for utilities before PUCs, in which they have to try to explain the high cost of their own generation resources in comparison to those of others. None of these pressures, however, nor any of the other developments mentioned so far, has in any way changed the basic franchise or quasi-franchise relationship between the utility and the retail customers. Nor has it changed any of the basically contractual fights and relationships between the utility and other utilities at wholesale. All of these pressures are caused by technological change, not by legislative or regulatory change. hat costs are claimed may tell us something about the cause of the "cost stranding" which is asserted. EEI asserts in its comments to the Federal Energy Regulatory Commission in FERC's stranded cost docket9 that there are over $75 billion in stranded costs, but the only such costs which EEI identifies in more than general way are "regulatory assets." All such "regulatory assets" are by definition costs which could not have been recovered in a competitive market but which have been capitalized for recovery to be permitted later by the PUC from the franchise or quasi-franchise customers, or which the recovery of
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ducer industry had previously been doing. They have constructed a number of generating units that are cheaper than many of those in the portfolios of the parent utilities, and have located them in areas where the utility portfolios are even more expensive.7This puts pressure on the utilities' own generation, as to which many have not been vigilant about controlling costs. All of this has expanded the secondary wholesale market in generation, in which "right to output" contracts are traded for periods ranging from a few hours to many
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the PUC for its own reasons determined to postpone. 1° EEI also asserts, with considerably less specifici~, that all generating reserves costs above marginal production costs have the potential to be stranded. While this point is never terribly clear, it appears to mean that they perhaps cannot be recovered from franchise or quasi-franchise customers. No such costs are claimed against other IOU customers who have bought for a period of years, whether or not they have used the transmission systems of those claiming the stranding, although EEI and others assert, rather halfheartedl~ that they should be able to collect such costs against nonIOU customers who have bought for a period of years, especially if they use the IOU transmission systems. All of the EEI comments, however, are really focused on state actions that would change their franchise or quasi-franchise customer base. n 'n other words, there is nothing .that has happened associated with any of the congressional or FERC actions that has "stranded" any costs so far. Unless the states abrogate the franchise or quasifranchise rights now in existence, the only "stranding" that has occurred is as a result of technological change or the construction by utilities of generation that is so expensive that it cannot be sold. ~2 The "restructuring" of the electric industry under consideration in many states (and which has generated a great deal of thought and paper in the California CPUC proceeding), which purportedly July 1995
drives the concept of the "grand bargain," has nothing to do with the FERC. It was initiated neither by Congressmindeed Congress prohibited FERC from requiring the direct customer access the states are considering--nor by any branch of the federal government. It is strictly a construct of the states responding to market pressures. In essence, California (which proposes permanent changes) and Michigan (which proposes changes as a limited experiment) expect to free almost all (for California) or a few (for
Michigan) retail customers to purchase generation resources on the bulk power market, rather than only from the vertically integrated utility to which they are attached. The utilities' stated concern is that those retail customers would purchase from suppliers which have no social costs imposed by the states, and without the large uneconomic generation costs with which many existing utilities (including the publicly owned utilities) in California and elsewhere are burdened. The basic premise that underlies both the Grand Bargain and many of the stranded cost arguments---
that costs have been stranded by federal actions---is basically false. While it is designed to pander to federal regulators' vanity, by convincing them that they have changed the world drastically rather than by making the process much more efficient, it is clear that the potential for any change that puts recovery of the claimed stranded costs at risk lies solely within the powers of the states. et us call a spade a spade. Utility costs that are "stranded" are stranded because the franchise and quasi-franchise customers that once were designated to bear those costs no longer will do so. That is either because the utilities' costs have gotten so high that the customer base left to pay the costs will be too small because of elasticity of demand, due to the state in question has abrogated the correlative rights and obligations of the utility and its retail customers. Nothing that has occurred at the federal level has caused that result. FERC has long held that there are no inherent obligations to serve at the federal level, so that wholesale relations are governed by contract. If the states wish to abandon the concept of a franchised retail provider, it is state action that causes the disconnection of that set of correlative rights and obligations. And if the utility has preserved its rights at retail with a franchise or equivalent, there is very little question that the state action constitutes a compensable taking for constitutional purposes. If the state "strands" costs, 13there is very lit-
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tie virtue or rationale in asking the federal government to pay for those costs or to have the federal government require competitors to pay for the costs that are claimed to be "stranded," especially w h e n those competitors have "stranded" costs of their own.
Neither FERC nor any other part of the federal government is responsiblefor the "stranding" of any of the costs asserted. Nor are the competitors. Indeed, as noted above, some of the competitors are simply the utilities themselves in other corporate guises. he idea behind the Grand Bargain, which is being p u s h e d by EEI and others in the stranded cost docket at FERC, seems to be that the federal government should require all consumers to pay higher rates for transmission services governed by FERC to p a y for costs caused by feared actions by the states that have not yet occurred. In an era in which " u n f u n d e d mandates" and "takings" are concepts which have attained significant emotional and political resonance in connection with federal imposition of costs on states, localities and citizens, it seems strange that the "grand bargain," which w o u l d have the federal governm e n t impose costs u p o n the citiz e n s ~ n o t because of anything the federal g o v e r n m e n t has done, and not even for any federal purpose, but to compensate utilities for damage which the states may do to them, or which technological advances have done to t h e m ~ doesn't pass the laugh test. It
seems as well to be running against a considerable political and economic tide. In the ordinary context, a utility that sought to charge twice as m u c h as its cost of service w o u l d warrant for its transmission service in order to drive its competition out of business w o u l d be thought to be stealing. That is because it w o u l d take the profits from one service where it had a m o n o p o l ~ and use t h e m to support--subsidize its generation service, which competes in a quasi-competitive market. That is precisely w h y tie-ins are per se il-
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TDUs have all of the overpriced generation--sometimes exactly the same overpriced generationm that the surrounding transmitting utilities have. Indeed, sometimes TDUs were induced to b u y into those units in order to obtain transmission rights to begin with. If transmission-owning competitors get to write d o w n their overpriced generation with m o n o p o l y profits, w h a t do TDUs get to write d o w n their overpriced generation with? Or are TDUs just p u t out of business, as m a n y of their competitors w o u l d prefer? Stealing is still stealing. The Grand Bargain w o u l d be grand larcen3a • Endnotes:
1. Perhaps more significantly, the numbers do not appear to work out and gold is not created from dross. That, however, is the subject of a more detailed analysis than is possible in the space available here.
legal under the antitrust laws. FPC v. Conway Corporation14m a d e it clear that this sort of thing is illegal in a regulated context as well. W h y is it different if the utility charges twice as m u c h as its cost of service in a one-time sale? It still takes the profits from a monopoly resource and uses them to subsidize its participation in a competitive market. Transmissiond e p e n d e n t utility competitors--those w h o are needed to make the competitive market that Congress prescribed function effectivelym have all of the social costs which are imposed on their competitors that o w n transmission lines.
2. The further system efficiencies tO be obtained from FACTStechnology are still being tested, but seem likely to be quite significant. 3. Reference to a "franchise or quasifranchise" right means that part of the "regulatory bargain" that includes an obligation on the part of a utility to provide power supply to a particular group of customers. While the particular customers in any such group may be a matter of dispute, it is clear that at least for those utilities with exclusive franchises in particular territories (or equivalent grants from the state) and the customers in those territories, there are correlative rights and obligations to serve and to take service. 4. The economies of scale which had been assumed to be available from ever-larger units turned out to be more than overcome by additional costs of operation and higher outage
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rates, and independent power producers began to develop generation and sell at much lower cost. 5. The author is one of the authors of the TAPS comments in the FERC stranded cost NOPR, FERC Docket No. RM94-7-000. Those comments include appendices of long-standing transmission arrangements in 31 states for which the information was readily available to TAPS, and also lists of municipal joint action agencies and generation and transmission cooperatives. Those lists show that by 1984, there were more than 53 joint action agencies in more than 30 states, and 52 G&T co-ops, many serving in more than one state. All of those enti6es had, or were in the process of obtaining through litigation or otherwise, some form of transmission access. 6. In the long run, the creation of an efficient market for generation services will, if not skewed by transmission owners, permit the sort of additional efficiencies that can develop from an actively competitive industrial segment rather than one constrained by artificial regulatory strictures. That would be a very significant accomplishment, and one that would add very considerably to the nation's welfare (not least in terms of industrial competitiveness in the world market). 7. This--and other evidence--suggests that the industry may again be in a declining cost phase. Whether this is true, and whether the reason for the declining cost phase (if it exists) is technological improvement, the perhaps temporary advantage of lowercost gas supply, or the impetus of the competitive market on design and construction techniques, are questions that are beyond the scope of this paper. It does, however, appear to be beyond dispute that the lower cost of the new generation is real and does not derive simply from the social or stranded cost burdens of utilities in the same market. 8. There have been active secondary wholesale markets of this sort for many years in places like New Eng-
July 1995
land and MAPP. Indeed, the whole concept behind the Western Systems Power Pool was to provide such a market in the West. However, it is this author's observation that the WSPP has not worked particularly well thus far because of the high transaction costs (and use costs) associated with transmission rights in that area. 9. Edison Electric Institute, Comments to Federal Energy Regulatory Commission, Docket No. RM94-7-000, at 18-27 (Dec. 9, 1994). 10. More than half of those regulatory assets that EEI asserts will be stranded are SFAS No. 109 costs, "income tax costs that would be expensed under GAAP, but are deferred for recovery through rates in the future when the tax costs are actually paid." The other
large category asserted by EEI--nearly a quarter of those regulatory assets---are "[p]hase-in, synchronization and other regulatory assets," which are said to "represent the costs of newly completed plants. Regulators require deferral to limit the impact on rates of the cost of new plants or to defer costs of new plants that would otherwise be unrecovered because of delays between the completion of the plant and changes in rates to reflect the recovery of such costs." Id. at 24, 27. 11. EEI also asserts concerns about "municipalization," carefully avoiding the fact that recent examples of municipalization all have been premised on obtaining whatever transmission service was needed prior to the passage of EPAct. The Town of Massena, New York, for example, obtained transmission well before to 1992. And
the City of Las Cruces, New Mexico, premised its late-1980s municipalization study, which is the basis for its present municipalization effort on being able to force transmission services from El Paso. Clyde, Ohio, which EEI cites as a horrible example (Id. at 59), established its municipal system in 1989, a fact that EEI takes care not to mention. While the passage of EPAct should have reduced the cost for litigation involved in forcing such transmission, EEI and others are seeking to impose an even higher barrier to municipalization than the pre-EPAct litigation cost through its bootstrap "stranded cost" argument. 12. The comment has been made that nuclear power has gone from being perceived as "too cheap to meter" to being perceived as "too expensive to matter." That newer perception is probably correct as to some of the more expensive nuclear facilities. 13. In addition to the regulatory asset claims made by EEI, note 10, supra, there have been assertions that high priced demand-side management and QF contracts are also "stranded." But those are unquestionably costs imposed by the state PUCs; FERC has had nothing to do with them. It may be that many IOUs chose not to contest arguments in favor of setting unrealistically high "avoided costs" because it made the option of completing an expensive generation project look good. But they certainly had the option to contest this and can hardly blame the FERC for their failure to do so. The case of Consumers Power Co. is instructive here. That large utility allegedly agreed to what many outsiders believed to be an excessive "avoided cost" rate to be fixed by the PUC, then contracted to buy 1240 MW of power from its own alleged QF affiliate, Midland Cogeneration Venture, L.P., and to apply that excessive "avoided cost" rate for at least 17 years. Opponents claimed that the windfall to MCV--and ultimately to Consumers Power's corporate parent--would be more than $1 billion. 14. 426 U.S. 271 (1976).
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